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Brexit: Implications for Commercial Contracts

21 July 2016

This note looks at some initial steps that businesses can take to identify and manage risk in existing and new contracts.

None of us yet knows with any certainty what Brexit will mean for the UK if and when Article 50 of the Lisbon Treaty is triggered. Assuming Article 50 is triggered, the UK will (at least in theory) then have two years to negotiate the terms of the UK’s exit from the EU. However, as there will be economic consequences for most businesses in the meantime, now is the time to consider existing and proposed new contracts with customers and suppliers to identify risks (and opportunities) and to plan strategies for those trading relationships.

The result of the referendum may mean that businesses wish to extract themselves from some contractual relationships. Conversely, some businesses may stand unexpectedly to profit from their contractual relationships. Well advised counterparties are likely to have considered the risks associated with their contractual relationships involving the UK. Successful, long-term trading relationships usually require a ‘win-win’ situation, so it would be wise to consider the impact of the referendum not only on your own business but also on that of your counterparties and to have a plan in place as to how you will approach this.

This note looks at some initial steps that businesses can take to identify and manage risk in existing and new contracts.

Existing Contracts

If you haven’t already, it is time to identify which of your contracts may be affected. In particular, think about the following issues:

  • Currency exposure: given the recent drop in sterling and likely on-going exchange rate fluctuations, it should be a priority to identify those contracts where payments are made or received in a foreign currency or are pegged to a certain exchange rate.
  • Liquidity and solvency: orders for goods or services involving large expenditure or capex may be postponed or cancelled. Identify which of your customers or suppliers, on whom you have a material reliance, may be adversely affected. You may wish to ensure that, wherever possible, you have adequate protections and contingency arrangements in place. This may, for example, involve a review of insolvency related termination rights. Also consider the consequences of termination, such as the existence and adequacy of your audit and retention of title clauses.
  • Material adverse change: if you are commercially exposed and a successful renegotiation is not on the cards, see if you have the benefit of a ‘material adverse change’ (MAC) clause, which may give you a ‘get out of jail’ card. These clauses are typically found in M&A or longer-term sourcing deals and usually allow a party to terminate or to pursue a different pricing strategy.
  • Force majeure clauses: similarly, if you find yourself in a tight spot, a widely drafted force majeure clause (which refers to acts of government, regulatory bodies or similar) might just provide you with the commercial leverage that you need, if only to force a renegotiation.
  • Regulation: if you operate in a regulated sector, such as financial services, much will depend on whether the UK can join the EEA via EFTA or have its regulatory regime recognised as ‘equivalent’, but in the meantime consideration should be given to how you will perform if regulatory permissions, such as EU passporting, are no longer available to you or your clients. For the time being at least, regulated businesses can continue to operate under their relevant passports as before.

New Contracts

With new contracts, ensure that you very carefully review the likely Brexit possibilities, especially where there could be a material adverse impact on risk, revenue and/or cost, and assess whether you have adequate contractual flexibility and/or commercial headroom to allow your trading relationships to prosper. In particular, think about:

  • Pricing mechanisms: most existing contracts will assume tariff and quota-free trading within the EU. Also, most businesses could, before the Brexit referendum, calculate their cost base with relatively certainty, including the cost of compliance with regulatory requirements and other costs based on the free movement of goods and people. In order to deal with the uncertainty of Brexit, and to maximise competitiveness, you may need to adopt more sophisticated pricing mechanisms which expressly allow adjustments on the occurrence of one or more pre-defined events.
  • MAC or Brexit clauses: as mentioned above, consider including a provision in your contract that enables you to terminate and/or to adjust pricing if one or more pre-defined events occur. Before you suggest this to your counterparty, do think about whether your customer or supplier might insist on a reciprocal right and, if so, whether, on balance, it remains appropriate to propose the provision.
  • Intra-group arrangements: the Anti-Tax Avoidance Directive recently agreed is unlikely to be implemented in the UK and public country-by-country reporting of tax liabilities seems unlikely to apply in the UK unless the EU designates the UK as a tax haven. However, EU Directives also provide protection from certain kinds of double taxation (e.g. intra-group withholding taxes) and include other tax measures which support free establishment within the EU. The UK’s double tax treaty network will not be affected by leaving the EU, but the EU protections are sometimes more generous. This may justify a re-think about the structure of royalty and other revenue flows and costs within group structures.
  • Territorial scope: whether you are dealing with franchises, software licences or the exploitation of other intellectual property rights, think about the extent of the rights being granted or received within the EU, and what ability you have to protect or adjust the scope of grant and/or associated revenue flows and cost commitments.
  • Exit planning: ensure you have adequate provisions to deal with an orderly and seamless exit. Unexpected events currently seem increasingly likely, so well considered exit planning will become more important.
  • Data and privacy: the ICO has made clear since the referendum that reform of data protection law is still required in the UK. It has said “If the UK is not part of the EU, upcoming EU reforms to data protection law would not directly apply to the UK. But if the UK wants to trade with the Single Market on equal terms we would have to prove ‘adequacy’ - in other words UK data protection standards would have to be equivalent to the EU’s General Data Protection Regulation (GDPR) framework starting in 2018.” The sensible approach for now is for businesses to continue to plan for compliance with the GDPR, especially as the GDPR will in any event have extra-territorial effect and, unlike the UK Data Protection Act, apply directly to data processors as well as to data controllers.
  • Intellectual property: it seems likely that there will be a process for EU TMs and registered Community Designs to be converted into UK rights. Nonetheless, contracts involving provisions dealing with registered trade marks or design rights, should be drafted to allow for additional UK registrations to be added to the scope of the contract.
  • Movement of workers: for now it is business as usual, but if the UK is unable to negotiate the continued freedom of UK nationals to travel within, and live in, the EU, there will almost certainly be additional cost and administration to be factored into the end pricing of goods and services. The same may apply for EU nationals wishing to work in the UK, who may be required to obtain visas under UK immigration rules.

So what next?

The best outcome for many UK businesses may be for the UK to achieve EEA membership through the European Free Trade Agreement (EFTA) (as is the case for Norway, Iceland and Liechtenstein) allowing the UK to continue to enjoy the benefits of free movement of goods, services, people and capital, but without the full privileges and responsibilities of EU membership. This would of course involve some fairly masterly negotiations with the EU and some political fudging in the UK (especially in respect of the free movement of people). The worst outcome may be a world of tariffs, quotas and no regulatory passporting or consistency. While most businesses that trade with the EU will no doubt hope for something closer to the first scenario, only time will tell what is negotiated.

Some may struggle to tolerate the uncertainty and some will, with curiosity and optimism, embrace it. What is certain is that those businesses who plan ahead will be far better placed to prosper in the future.

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